The weather remains fabulous here. I spent the last two days in Osaka, enjoying bright blue skies and 30-degree heat. However, summer is drawing to a close in the evenings, and I sense chillier times ahead for both the weather and the market. The country is awash with tourists thanks to Expo in Osaka, it was impossible to move. Even my morning swim was interrupted by Anglo/Chinese lane etiquette.
Ms. Takaichi won the Liberal Democratic Party (LDP) leadership on her third attempt. Mr. Aso backed her at the last minute, and Mr. Koizumi junior was too lightweight. At the time of writing, the Komeito has declared its intention to no longer be in coalition with the LDP. Whilst Ms. Takaichi is still the favourite to be PM of a minority government, it is far from certain. We hope that the LDP can work with the Democratic Party For the People (DPP), as they are aligned at least on tax policy.
It is clear from my trip that prices are rising everywhere and real wages remain under pressure. The hotel I’m staying in has doubled in price since COVID, and everyday goods have all increased. Labour is tight, and every company I spoke to complained about this issue and the cost of raw materials. The weaker the Yen, the greater the chance of a Bank of Japan surprise in October, but January seems more likely. Every ¥10/$1 weakening may add +0.3% to CPI.
Capital expenditure is booming in software, datacentre construction, and labour-saving automation. The government is supporting onshoring of chip spending (Rapidus) in Japan. The threat of China looms everywhere; they are eating into many lower-end Japanese factory automation companies’ market share in China. The battle will be intense to incorporate software, automation, robotics, and AI. Only the best Japanese companies will survive.
As I write, the Nikkei 225 is hitting all-time highs. Yet, I’m reminded of Q4 1999. Will all this AI spending be matched by revenue, or will someone waste a ton of money? I don’t know the answer, but when you consider that Softbank’s purchase of ABB’s robotics business for $5bn lifted Softbank’s market cap by $11bn, you wonder if you’re living in a parallel universe.
Of the thirty-three sectors in the main market, only eight have matched the market in the last four weeks. The Non-Ferrous sector contains companies in wiring hardware and metals for semiconductors, which is largely why this has performed so well. Since the Trump volte-face in April, Fujikura is +220%, Softbank is +206% (2% of the Index). In Defence, IHI Corporation is +100%, Mitsui Engineering +189%, Disco (semi cutting tools) +80%. None of these have been held at Zennor. We have continued down our own idiosyncratic path. With Palantir trading at 300x sales multiples, the risk is that Japan is heading in a similar direction. Advantest in semiconductor production equipment trades at 44x forward earnings, and Disco at 40x. Mitsubishi Heavy in defence spending was at 0.5x book value and now trades close to 6x.
As always, we are doing things differently. David did a great job visiting Tekscend Photomask in August (429A), which trades at 12x PER. Although it won’t have a 100% correlation to AI, it should be a steady +10% compounder of EPS. We participated in the new issue. The visits I have made to existing names suggest earnings are in line or slightly better. We are more focused on corporate governance change than AI. Japan is experiencing rapid de-equitisation; I think the number of listed companies could shrink by 25% over time. MBOs, takeovers, tenders, buybacks, dividend increases, restructuring, higher ROIC, and a greater awareness of the cost of capital, which are the themes that will outpace AI. But for now, the music plays and everyone dances until it stops. There are some warning signs emerging in the private credit market this week, which worry me. Back in the mid-eighties, when I was doing my degree, electric utility companies rose 4x in six months. Many technology stocks have done that, or nearly so, in the past six months.
The Yen will eventually strengthen. I am amazed that Sterling has remained so strong despite fiscal headwinds. But a BOJ surprise is not off the table. Existing holdings I saw this week with strong earnings momentum and attractive valuations include NS United Kaiun Kaisha (9110), Tsubakimoto Chain (6371), Daiwa Industries (6459), Sakai Chemical (4078), HI-LEX (7279). Sakata Inx (4633) looked very interesting as a new idea.
So, fellow investors, enjoy the long-haul flight with us, not the funfair ride happening in Gatsby-esque tech land!
